A guide to Non-Resident and Types of transactions under FEMA

An Indian residing abroad is generally known as a Non-Resident Indian (NRI). NRI means a person residing outside India who is a person of Indian origin or a citizen of India. Let us know about the Non-Resident and types of transactions under FEMA.

NRI as per FEMA

NRI includes a Person of Indian Origin (PIO). A PIO is a person who has at any time held an Indian passport, or who, one of his parents or grandparents was a citizen of India or the spouse of the person.

According to FEMA, a resident of India means a person who has been resident in India for more than one hundred and eighty-two days (182 days) during the preceding financial year (April-March) and who has entered or resides in India, whether for admission to employment, business or profession in India or for any other purpose which would intend to stay in India for an indeterminate period. 

In other words, to be considered as a ‘Resident of India’ as per FEMA, a person must not only fulfill the condition of stay (more than 182 days during the preceding financial year) but also fulfill the condition of purpose/intent of stay.

Foreign Exchange Dealing

Section 3 of FEMA, unless otherwise provided by law, restricts a person to-

• Withdraw or transfer any foreign currency or foreign security to anyone other than an authorized person;
• Make any payment in foreign currency or receive any payment from any person resident outside India; 
• iii. to accept other than through an authorized person any payment to the order or on behalf of any person resident outside India; 
• Enter into any agreement to enter into any financial transaction in India as consideration for the purchase or creation or transfer of the right to acquire any asset outside India by any person.

This means that foreign exchange transactions can only be carried out in the manner prescribed by law.

Capital and current account transactions

The basis of FEMA is capital and current account transactions. All transactions involving residents and non-residents are classified as capital and current account transactions.

The golden rule for identifying a transaction as a capital account transaction is that unless the transaction is specifically permitted, it is prohibited by FEMA, and the golden rule for identifying a current account transaction is that a particular transaction is permitted unless expressly prohibited or specifically regulated by FEMA.

Although the above definition is easy and simple enough to understand, its application is not an easy task because of the subjective interpretations of the definitions of both capital and current accounts.

What is a current account transaction?

A current account transaction has been defined as a transaction other than a capital account transaction and includes transactions such as payments due in connection with foreign trade, other ordinary trade, services, short-term banking and credit instruments received in the ordinary course of business, payments, which are payable as interest on loans and also as net income from investments, remittances sent for living expenses of parents, spouse and children who reside abroad, as well as expenses related to education, foreign travel and medical care of parents, spouse/ wives and children.

What is a capital account transaction?

A capital account transaction is a very subjective definition and includes such transactions which change ‘assets’ or ‘liabilities’ and also include ‘contingent liabilities’ of both non-residents of India and non-residents of India. Section 6(3) also provides for regulated capital account transactions such as transfer or issue of any Indian security by a non-resident, transfer or issue of foreign security by a resident of India, borrowing or lending, etc.

It should be noted that terms such as “assets”, “liabilities”, and “contingent liabilities” have not been defined under FEMA, making it difficult to determine whether a transaction constitutes a capital account transaction or not. A quick response to finding the meaning of the mentioned terms is to search for their meanings in accounting practice. However, the RBI has not prescribed whether the said practice would be the correct approach to determine the meanings of these terms.

Transactions when not admissible under FEMA

There are many situations where a particular transaction may fall into a “grey” area of admissibility under FEMA. A few transactions are mentioned below. In all these examples, you need to determine whether they fall into the category of capital account transactions or current account transactions.

Exclusivity fee:

• An exclusivity fee paid during a corporate acquisition or investment transaction is typically paid to ensure that the party to whom the fees are paid will not be able to negotiate the same type of transaction with another party for a while.
• According to FEMA, no provision stipulates the payment of an exclusivity fee between a non-resident and a resident. Because the exclusivity fee is associated with a transaction involving capital instruments of the Indian economy, which is a capital account transaction. Therefore, such payments should be considered capital account transactions, ideally permitted under FEMA.
• Exclusivity can also be used to set off against the purchase price payable by the buyer. In this case, it will be treated as a capital account transaction and if the exclusivity fee is not included as purchase consideration, such payment may qualify as a capital account transaction.

Non-compete fee:

• The payment of non-compete fees has been particularly in vogue since changes were made to the regulations relating to listed company transactions. This non-compete fee is paid by the buyer to the seller to limit the seller or another person from competing with the buyer for a while.
• Since these non-compete charges are linked to the purchase and sale of shares, they can also be treated as a capital account transaction and are not covered by the general permission of the RBI.

Damages and compensation:

• According to the rules for the Foreign Exchange Management (non-debt instruments) from 2019, it states that in the case of the transfer of instruments between a non-resident and a resident, when an amount not exceeding 25% of the total consideration can be paid by the seller as compensation to the buyer within a period not exceeding 18 months from the date of payment of the full consideration, – if the full payment has been paid by the buyer.
• In addition to the foregoing, FEMA does not expressly authorize or authorize the payment of compensation or damages for a share subscription or share acquisition transaction in a transaction where there is a sale and purchase or subscription of capital instruments.
• If the payment of damages can be termed as a current account transaction, then such a payment between non-residents and residents would be permitted because the payment of damages was not expressly prohibited.

Final words

While working on various types of transactions involving investments, acquisitions, residents, non-residents, etc., it is necessary to check whether such transactions are permissible under the Foreign Exchange Management Act (FEMA), Foreign Exchange Management Rules, and other related notifications, circulars, notices, etc. Since the Act cannot provide for all permissible transactions, the Act simplified matters by classifying each such transaction into the two broad categories of capital and current account transactions under FEMA.